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The Bank of Canada now says it was wrong about how strongly the Canadian economy has been recovering and has changed its tune on raising interest rates, which will likely stay put at one per cent for some time.

In an unusually detailed and dour statement at Tuesday morning's policy rate announcement, the central bank's governing council said it now expects the recovery to be so protracted that it will take a full year longer to return to full capacity than it had thought.

As expected, the bank kept the trend-setting policy rate at one per cent after three straight increases since June that had put it in a lonely club of one among the G7 big economies when it comes to withdrawing monetary stimulus.
 
"The economic outlook for Canada has changed,'' the bank's senior officials wrote.

"At this time of transition in the global recovery, with a weaker U.S. outlook, constraints beginning to moderate growth in emerging-market economies and domestic considerations that are expected to slow consumption and housing activity in Canada, any further reduction in monetary policy stimulus would need to be carefully considered.''

That bank said it now believes Canada's economy will likely grow about three per cent this year instead of the 3.5 per cent it had predicted in July - and that's all due to a faster-than-expected start to the year.

Next year will be even worse, with moderate growth of 2.3 per cent, six-tenths of a point lower than previously projected.

It's not until 2012 that the bank sees the economy gathering steam, but at 2.6 per cent, that's still far below Canada's historic growth levels during expansionary periods.

More surprising was how far the bank's senior officers set back the time frame for the economy to return to normal, or full-capacity - to the end of 2012 from the previously thought end of 2011.

"This more modest growth profile reflects a more gradual global recovery and a more subdued profile for household spending,'' they wrote.

The bank said with household debt so high, it expects Canadians will spend less on consumer goods and on homes, meaning the housing market is in for a protracted cooling-off period.
 
Given that Ottawa is phasing out fiscal stimulus in March and consumers don't have the means to keep spending, the Canadian economy will need to depend on exports and business investments, two sectors that have been extremely weak over the past few years.
It warned that exports will be sensitive to currency movements, a reference to efforts by the U.S. to devalue their dollar and corresponding strength of the loonie.

For the rest of the world, the coming fight over currency exchange rates - largely between China and the U.S. - and unresolved global imbalances will result in a more "protracted and difficult recovery,'' the bank said.

Currency manipulation has emerged as the most contentious issue at the upcoming G20 finance ministers meeting later this week and leaders summit in November, both in Korea, with the potential to split the group between advanced and emerging nations.

The U.S. recovery will be particularly weak, it noted, with the corresponding drag on Canadian exports south of the border.

Even growth rates in emerging economies are expected to ease, the bank wrote, as fiscal and monetary policies are tightened.

As for prices, the bank's key focus, its best guess is that both total and underlying inflation won't reach the bank's two per cent target until the end of 2012. 

Courtesy of the Canadian Press, October 19, 2010